FA MODULE 2: ACCOUNTING EQUATION

LECTURE 1:The Accounting Equation

The basic accounting equation is expressed as:
Assets = Liabilities + Owner’s Equity
The basic accounting equation serves as the foundation in analyzing
business transactions. However, only the three basic accounting elements
are expressed in the basic accounting equation. To make it easier for
accounting students to analyze accounting transactions, the expanded
accounting equation was introduced.
The expanded accounting equation is expressed as:
Assets = Liabilities + [Capital + (Revenue – Expense) – Drawing]
LECTURE 2: The Accounting Elements
1. Assets
 anything that the business owns, such as cash, land, building,
car, office equipment, computer, etc.;
 rights that are convertible into cash or another form of asset,
such as accounts receivable (the business has a right to collect
the receivable from a customer if it performs a service or sells
merchandise and the customer did not pay cash at the time of
purchase), patents (rights granted to the inventor of products
or technology), copyrights (rights granted to authors,
musicians, composers, singers, painters, artists, sculptors,
etc.); and
 prepaid expenses such as when the business makes a
payment for car insurance covering a period of one year or
makes advanced payment for one-year rent.
Assets are classified into current assets, non-current assets,
temporary investments, and long-term investments.
1. Current assets are cash and non-cash assets that will be
converted into cash or will be consumed, used, or will expire
within one year. Cash, accounts receivable, merchandise
inventory, supplies, prepaid expenses such as prepaid insurance,
office supplies, notes receivable collectible in one year are
examples of current assets. Cash includes bills, coins, checks and
money orders that are still in the possession of the business and
have not yet been deposited; and money in the bank that is
readily available for use. Accounts receivable pertains to
outstanding accounts that are collectible from customers for
products sold or services rendered on account. Merchandise
inventory are goods on hand that are intended to be sold to
customers. Prepaid expenses are expenses paid in advance that
will be used, consumed, or will expire within one year.
2. Non-current assets are assets that are useful to the business for
more than one year or one operating cycle, whichever is longer.
Long-term assets are also known as
 plant assets;
 fixed assets;
 property, plant and equipment; and
 long-lived assets.
3. Long-term assets are classified into tangible assets, intangible
assets, and natural resources or wasting assets. Tangible assets
are long-term assets with physical substance (perceived by the
senses), such as land, building, car, computer, office furniture
and fixtures, etc. Intangible assets are long-term assets that have
no physical substance. These are, basically, rights that have
monetary value such as copyrights, patents, goodwill, and
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trademarks. Natural resources or wasting assets are long-term
assets that are exhaustible or depletable. Once consumed, they
are not replaceable such as mineral deposits, marble deposits, oil
deposits, coal deposits, etc.
4. Temporary investments or short-term investments are
marketable securities that the company intends to convert to cash
within a period of one year.
5. Long term investments consist of investments in stocks, bonds,
and other financial instruments, that the company intends to hold
for a long period of time, for more than one year.
2. Liabilities
 are the debts (indebtedness, loans, or payables) of business,
anything that it owes. Businesses often incur liabilities in the
course of their operations. Sometimes businesses decide not to
pay cash when they buy assets or incur expenses. When this
happens, it gives rise to liability. Liabilities are classified based
on their maturity period; current liabilities mature within one
year, whereas long-term liabilities are due after one year.
Some commonly known liabilities are:
accounts payable - a current liability that results when a
business does not pay cash when the asset is purchased or
expense is incurred;
 notes payable - a liability that results when the business
issues a promissory note to serve as evidence of its
indebtedness;
 mortgage payable - a long-term liability that results when
the business gets a loan backed up by a real estate
property as collateral;
 wages payable - a current liability for unpaid wages for
services already done by employees;
 interest payable - an unpaid interest on outstanding loans
or liabilities; and
 unearned revenue - a current liability for advanced
collection of revenue for products not yet delivered or
services not yet rendered.
3. Owner's Equity
 is the claim of the owner/s in the assets of the business. There
are two parties who have legal rights to the assets of the
business: the owners and the creditors. The creditors' claims
are represented by the liabilities while the claims of the
owner/s are represented by the owner's equity. In the
expanded accounting equation, owner’s equity is expressed as
C + (R - E) + D.
 Capital is the balance of the owner’s claim in the assets
of the business. it is composed of the original
investment of the owner/s, increased by the cumulative
owner’s additional investments and net income, and
decreased by the cumulative net losses and owner’s
drawings or withdrawals (dividends for corporations).
 Revenues represent the total amount of products or
services billed to customers. At the time of sale, the
customers can pay for the product or service through
cash payment or payment on account or on credit. if
payment is on account, the transaction gives rise to
accounts receivable. if the customer, instead of making
a cash payment, issues a promissory note, then it gives
rise to notes receivable.

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 Expenses are the costs and charges that the business
incurs to earn the revenues. The most common
expenses are rent expense, utilities expense, wages
expense, transportation expense, supplies expense,
delivery expense, travel expense, gasoline expense,
telephone expense, taxes and license expense,
depreciation expense, insurance expense,
miscellaneous expense, interest expense, etc. In the
income statement, expenses are deducted from
revenues to arrive at the results of operations, which
can either be a net income or net loss. if expenses are
less than revenues, then the business made a profit or
net income. If expenses are greater than revenues, then
the business suffers a net loss for the period.
 Drawing represents the withdrawal of cash or other
assets by the owner from the business, for his personal
use. The equivalent of drawing in a corporation is
dividends, which represent the return that stockholders
earn from investments in the corporation. Drawing and
dividends effectively reduce capital.
LECTURE 3: Importance of Understanding the Accounting Elements
 The pillar of the basic foundation of accounting knowledge rests on
a very good understanding of the accounting elements.
 It is very important to know all the six accounting elements because
the rules of debit and credit that are used in the analysis of
transactions, recording in the general journal, and posting in the
general ledger are based on the accounting element affected by the
transaction. Likewise, in the preparation of financial statements, the
accounting elements also dictate the financial information shown in
each particular financial statement.
 In analyzing transactions, recording in the general journal, and
posting to the general ledger, the rules of debits and credits are used
to identify the necessary action (debit or credit) to the affected
accounts. The rules of debits and credits are based on the affected
accounting. elements. In the preparation of financial statements,
again, items shown in each financial statement are also based on
the accounting elements. This means that accounting elements are
exclusively shown in specific financial statements, except for ending
capital that is reported in both the equity statement and the balance
sheet. Remember this when the analyzing, posting, and reporting
processes are discussed in later chapters.
LECTURE 4: Effects of Transactions on the Accounting Elements
 Let us use the transactions of Efficient Services for the month of
December 2017 in understanding the expanded accounting
equation. The transactions are analyzed from the point of view of the
business, Efficient Services.
Date Transactio
ns
Dec 1 Received Php 1,000,000 cash investment from Clark Kent
. to start the Efficient Services. Issued official receipt (OR)
001.

Asset cash increased by Php 1,000,000 and capital of Clark

Kent increased by the same amount.
2 Issued check (CK) 001 for office supplies, Php 3,000.

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Asset office supplies increased by Php 3,000 and the

payment of Php 3,000 decreased asset cash.
3 Bought computer from Best Buy, Php 35,000. Issued CK
002 for Php 3,000 down payment. Balance is on account.

Asset computer increased by Php 35,000. The asset cash

decreased by the Php 3,000 down payment while the
liability accounts payable increased by Php 32,000.
6 Bought delivery van from A-J Car Dealership, Php
1,500,000. Issued CK 003 for Php 200,000 down payment.
Balance is on account.

Asset delivery van increased by Php 1,500,000, asset cash

decreased by Php 200,000, and the liability accounts
payable increased by Php 1,300,000 (PhP1,500,000 -
200,000).
7 Paid rent for one year, Php 60,000. Issued CK 004.
Asset prepaid rent increased by Php 60,000 and asset cash
decreased by the same amount.
8 Performed services for cash, Php 275,000. Issued OR 002
and service invoice (SI) 001.

Asset cash increased by Php 275,000 and revenues service

fees increased by the same amount.
9 Performed services, Php 100,000. Issued OR 003 for the
Php 10,000 down payment and SI 002 for the full amount.
Balance Is on account.

Revenues, service fees increased by Php 100,000; asset

cash increased by the Php 10,000 for the down payment and
asset accounts receivable increased by the Php 90,000
balance (100,000 - 10,000).
1 Obtained bank loan, Php 500,000. Issued promissory note
3 (PN) 001.

Asset cash Increased by Php 500,000 and liability loans

payable is increased by the same amount.
1 Paid Php 3,000 for van maintenance expense. Issued CK
4 005.

Expense, van maintenance expense increased by Php 3,000

and asset cash decreased by the same amount.
1 Paid wages, Php 30,000. Issued CK 007. CK 006 was
5 voided.

Asset cash decreased by Php 30,000 and expense, wages

expense increased by the same amount.
1 Performed services, Php 200,000. Issued OR 004 for the
6 Php 50,000 down payment and SI 003 for the full amount.
Balance is on account.

Revenues service fees increased by Php 200,000. Asset cash

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increased by the Php 50,000 down payment while another

asset, accounts receivable, increased by Php 150,000
(PhP200,000 - 50,000).
1 Issued OR 005 for Php 60,000 collected from customers
7 (see Dec 9).

Asset cash increased by Php 60,000 and asset accounts

receivable decreased by the same amount.
1 Issued CK 008 as payment for telephone expense, Php
8 2,000.

Expense, telephone expenses increased by Php 2,000 and

asset cash decreased by the same amount
1 Issued CK 009 as payment for electric bill, Php 4,000.
9
Expense, electricity expenses increased by Php 4,000 and
asset cash decreased by the same amount.
2 Issued CK 010 as payment to Best Buy, Php 16,000 (see
0 Dec 3).

Asset cash decreased by Php 16,000 and the liability

accounts payable decreased by the same amount.
2 Issued CK 01 1 payment to A-J Dealership, Php 500,000
1 (see Dec 6).

Asset cash decreased by Php 500,000 and liability accounts

payable decreased by the same amount.
2 Issued CK 012 to Clark Kent for cash withdrawal, Php
2 40,000.

Drawing, Clark Kent Drawing increased by Php 40,000

while asset cash decreased by the same amount.
2 Collected Php 100,000 from customers on account. Issued
3 OR 006.

Asset cash Increased by Php 100,000 and asset accounts

receivable decreased by the same amount.
2 Paid entertainment expense, Php 10,000. Issued CK 013.
8
Expense, entertainment expenses increased by Php 10,000
and asset cash decreased by the same amount.
3 Paid wages, Php 30,000. Issued CK 014.
0
Asset cash decreased by Php 30,000 and expense, wages
expense increased by the same amount.

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